Interference by courts to restrain invocation of unconditional letter of credit or bank guarantee is limited to grounds of fraud and irreparable/irretrievable harm/injustice. The term irretrievable harm/injustice is also referred to as special equities.
The Supreme Court has held that in order to restrain the operation of irrevocable letter of credit or bank guarantee, there should be serious dispute and there should be good prima facie case of fraud and special equities in the form of preventing irretrievable injustice between the parties. It has also held that to make out a case for irretrievable injury, such injury must be of the kind which was the subject-matter of the decision in the Itek case, i.e., there were “exceptional circumstances which make it impossible for the guarantor to reimburse himself if he ultimately succeeds, will have to be decisively established” and “mere apprehension that the other party will not be able to pay, is not enough”. [See decisions of Supreme Court in Svenska Handelsbanken v. Indian Charge Chrome (1994) and U. P. State Sugar Corporation v. Sumac International Ltd (1997)]
This article discusses the ground of irretrievable harm in the context of a recent decision of the Delhi High Court where the court granted interim relief.
A US exporter entered into a contract with the Iran Government to manufacture certain high-technology optical equipment. Iran Government was required to make an advance payment to Itek of USD 4,500,000. Itek was obliged to (i) provide security for this advance by 4 bank guarantees issued by Iranian bank and (ii) furnish a bank guarantee in the amount of USD 2,250,000 issued by Iranian bank as security for the good performance of its contractual obligations.
Iranian bank required Itek to supply stand-by letters of credit in its favour, issued by an American bank and Itek provided five letters of credit issued by American bank and naming Iranian bank as beneficiary.
The contract between Itek and the Iran Government provided that in the event of force majeure, including the cancellation of Itek's export license covering the equipment, either party would be entitled to inform the other of the event constituting force majeure and, after three months, to cancel the contract by written notice. Upon cancellation, the parties would clear their account and release all guaranties and letters of credit.
The court found that the demands made by Iranian bank on all three letters of credit were non-conforming, received after the expiration dates, there was fraud in the transaction. Therefore, the letters of credit were without any legal force, and were null and void.
With respect to irreparable harm, the court asked whether the plaintiff is likely to suffer irreparable injury is tested by asking whether the plaintiff has available a legal remedy adequate to compensate it for its injuries? Itek argued that there is no adequate legal remedy. If American bank made payment on the letters of credit, Itek's only recourse would be a lawsuit against the Iran Government, which cannot be viewed as an "adequate" remedy as the domestic situation in Iran has rendered access to Iranian courts futile. Accordingly, the court held that Itek has demonstrated that it has no adequate remedy at law and its allegations of irreparable harm are genuine and immediate.
Delhi High Court
Leighton and DLF entered into a contract dated 19 September 2013 for developing a residential project “The Camellias” in Gurgaon. The date of completion of the project was 3 September 2017. After the initial contract, DLF placed several variation orders on Leighton and the date of completion was revised with last extension granted till 30 June 2018. Leighton furnished 6 bank guarantees (BGs), 2 in lieu of retention money and 4 to secure the proper performance of the contract. All the BGs were valid till 31 May 2020.
On 7 April 2020, DLF sent a letter to Leighton pointing out certain defects, as a basis for invocation of BGs worth approximately Rs. 200 Crores. On 4 May 2020, BGs were encashed. Leighton filed a petition under Section 9 of the Arbitration and Conciliation Act, 1996, against DLF Limited and Axis Bank, seeking to restrain DLF from encashing BGs till the conclusion of arbitration proceedings or in the alternative if the amount is encashed, deposit it with Leighton.
Leighton contended that (i) it completed the project by September 2017 but because of variation orders placed by DLF, some part of the work continued but a substantial that substantial part of the work had already been completed. Since June 2018, Leighton had been asking DLF for completion certificate; (ii) defects highlighted in DLF’s letter of 7 April 2020 are extremely minor for which invocation of BGs of more than Rs.200 crores is unjustified; (iii) defects are being pointed out 2 years after completion to avoid issuing completion certificate and releasing BGs; and (iii) Leighton was not given any notice regarding the invocation of the BG by the respondents.
DLF contended that (i) the petition was infructuous as by the time it was filed, the BGs were already invoked and the amounts were credited to DLF; and (ii) Leighton’s reply to DLF’s letter dated 7 April 2020 was given 4 May 2020 much after the invocation of BGs.
Decision of the Court
Because the reliefs sought for restraining invocation of BGs were infructuous; the court allowed the alternative relief and directed DLF to secure the amount of performance BG of Rs. 143 Crores in a fixed deposit with the court. The basis of the court’s decision was an inquiry into whether DLF ought to be directed to refund the amount, having encashed the BGs, or to secure the amount. It observed that DLF’s notice of 7 April 2020 shows that the work to be carried out/rectified, when compared with the total expense and cost of the project, does not appear to be substantial when compared with the total value of the BGs encashed. The performance BGs were issued to secure faithful performance of the contract and DLF’s letter of 7 April 2020 while pointing out certain defects, did not disclose unfaithful performance or non-performance by Leighton. At best these are arbitrable disputes and could not have led to invocation of BGs. Whether 7 April 2020 letter could have led to encashment of BGs while BGs were still valid till 31 May 2020? Leighton was not intimated about encashment of BGs and encashment in this manner, during lockdown is not completely bona fide.
In the existing facts, under the contract, DLF could invoke the performance BGs only in circumstances which entitled DLF to terminate the contract, on default by Leighton. Although DLF alleged breach/default by Leighton, no notice of termination was issued by DLF. The contract between the parties continues to subsist. The parties were actively working with each other in a collaborative manner when BGs were invoked in a distrustful manner. In these facts, special equities exist to protect Leighton’s interest and secure the amount of performance BGs.
To satisfy the test of irretrievable injustice or special equites, the question to ask as in Itek would be whether Leighton has available a legal remedy adequate to compensate it for its injuries? If not, it is likely to suffer irreparable harm.
Leighton did not argue that that it met the test as laid down by the Supreme Court, based on Itek, in U. P. State Sugar Corporation v. Sumac International Ltd (1997), that there were “exceptional circumstances which make it impossible for the guarantor to reimburse himself if he ultimately succeeds, will have to be decisively established” and “mere apprehension that the other party will not be able to pay, is not enough”. However, the court granted an interim protection and directed DLF to secure the money in a fixed deposit with the court. Could this have been done without Leighton proving (and arguing) that DLF will not be able to pay the money encashed if it were required to repay in due course?
This decision was cited by the Petitioner but the court does not seem to have taken note of the test laid down by the Supreme Court or even Itek decision. It appears to have been persuaded by the fact that the BGs were invoked in a distrustful manner and, therefore, special equities existed to protect Leighton’s interest and secure the amount of performance BGs. Leighton did not argue fraud in this case.
Additionally, (i) there was no finding on the balance of convenience in favour of Leighton as to how the injury to Leighton outweighs the harm which granting the interim relief would inflict on DLF; (ii) the relevance of the invocation of BGs during the lock in period is not clear; (iii) the relevance of a right to terminate to the right to invoke BGs is also not clear.
In my humble opinion, the court ought to have applied the test of irretrievable harm laid down by the Supreme Court in U. P. State Sugar Corporation v. Sumac International Ltd (1997).